Tax reform dominated the airwaves in October but before it could tackle tax reform, Congress needed to successfully pass a budget. By a narrow margin the budget passed on October 26th and Republicans immediately turned to drafting a new tax plan. The administration is under great pressure to produce tax reform for the America people before the end of 2017 because it was a main plank in the GOP platform that put this administration in power.
Everyone on both sides of the argument agrees that our tax system needs to be simplified and taxes need to be reduced. The struggle comes because there are as many opinions on how to do this as there are politicians talking about it.
It is okay to cut taxes as long as the revenue coming into the government coffers remains the same. It is what is referred to as “revenue neutral” or when you hear that tax cuts have to be “paid for”. Well, how do you do that?
You do that because eliminating a deduction has the same impact on your net as raising taxes. It just sounds better to say you closed a loop hole or you eliminated a deduction rather than you raised someone’s taxes. If you cut taxes for one taxpayer you must close a loop hole somewhere else which raises taxes for another taxpayer. You shuffle things around and end up with the same revenue. Doesn’t that sound like rearranging the deck chairs on the Titanic?
Tax reform which truly lowers taxes should also include budget reform that lowers spending. Everyone wants lower taxes, but no one wants government spending to be cut. Therein lies the conundrum. It is popular to cut taxes. It is not popular to cut spending!
We can expect to hear Congress wrangle about tax reform for the remaining weeks of 2017 and investors will watch closely to see first of all if anything will be accomplished in 2017, and if so, exactly what. If corporate taxes are reduced there will be more money for businesses to hire and to grow by investing in new technologies, machinery, and infrastructure. And, if consumers take home more in their paychecks, then they have more to spend and invest. All this is positive for stocks. One thing is certain, tax planning will remain critically important to all investors.
Investors have been patient because they really preferred to see a tax plan passed in the first few months of the year. If it doesn’t happen in 2017, that could be negative for stocks. Whether a tax plan is already priced into the market remains to be seen. If so, it could mean there is not a lot more upside if a tax proposal passes and if it does not pass it could trigger a drop in the market.
Investor sentiment is unusually positive as buying begets buying and investors have a fear of missing out instead of a concern for the extreme risk at current levels. It does not take much to send investors fleeing at these levels. It is critical to have a plan to manage risk.